Choosing Between Chapter 7 and 13 after Closing Your Business

If you’ve already closed down your unsuccessful business, or are thinking of closing one you are now operating, you must be wondering what’s the best way to deal with the debts that are now saddling you from that business. The answer depends on many factors, including the type of debts that you owe. Here are some of the main kinds of legally different business debts, and how Chapter 7 and Chapter 13 would each deal with them.

Income and Withholding Taxes

Very often the closing of a business leaves the owner personally liable on most or all of the business’ tax obligations. You likely also have your own personal tax obligations that you couldn’t afford to pay during the months and years that the business was struggling. This usually happens when your business had generated enough money for you to get some income from it, but not enough to meet personal living expenses much less enough to pay the taxes on that income.

Whether you owe back taxes, how much, and what kind are often the most important questions in deciding whether to file a “straight bankruptcy” Chapter 7 case or instead an “adjustment of debts” Chapter 13 one.

Chapter 7 can be the right choice if 1) the taxes owed can all be discharged (legally written off), or 2) if the taxes—or the portion still owing after discharging some—are relatively small, and can be paid off through a manageable monthly payment plan with the IRS or other tax agency.

However, if the taxes which cannot be discharged are very large, and especially if they span a number of years, then Chapter 13 if often the better choice. That’s because Chapter 13 provides a number of advantages that all the more worthwhile if you owe a lot of taxes and need more help.

For example, under Chapter 13 you are protected from the IRS’s collection efforts throughout the three to five years that the case lasts. You have that length of time to pay those taxes that must be paid. The payment amounts are based on what you can afford to pay, not on what the IRS or another tax entity demands. Interest and tax penalties do NOT continue to accrue in most situations. You can often pay other personally important debts—such as a vehicle or mortgage arrearage or payment—ahead of the taxes. Also, if your circumstances change during the three-to-five-year period, usually adjustments can be made to your payment amounts, again based on what you can afford to pay.

In a nutshell, if you can reasonably pay the taxes you owe as a result of your business closing after discharging all or most of your other obligations (including maybe some of the taxes), then Chapter 7 may well make more sense. Otherwise, you probably need the stronger medicine of Chapter 13.

Debts Secured by Business Equipment

Most of the time when a business has debts secured by collateral—such as business equipment, inventory, or receivables—when the business closes it surrenders the collateral to the creditor, and the remaining debt is treated as a “general unsecured” debt. (See the next section.)

But you may want to keep certain collateral—such as a business vehicle or tools that you will need for your future livelihood. Assuming that the collateral is titled in your name (usually the case if your business was a sole proprietorship and not a corporation), and also assuming that you are personally liable on the debt, then if you are current on this debt you will likely be able to keep the collateral. You just have to agree to continue making payments and to continue being liable on the debt. This can usually be done through a Chapter 7 case.

However, if you are not current on the secured debt, and can’t get current quickly, you may need Chapter 13 to hang onto the collateral. This option will almost always give you more time to catch up. Or in some situations, you may not even need to catch up on the payments, and may even be able to keep the collateral in spite of paying less than what you owe on it.

So, in some situations you can keep the collateral under Chapter 7. But if not then you would likely benefit from the extra benefits that Chapter 13 provides.

“General Unsecured” Debts

This last category covers debts that have no collateral, and also do not fit within any categories of “priority” debts (such as recent income taxes) that must be treated in special ways. General unsecured debts are usually discharged under both Chapter 7 and Chapter 13, so they do not generally drive the decision either way.

There IS a limit on how much general unsecured debt you can have in a Chapter 13 case—a maximum of $383,175 starting April 1, 2013 (and for the following 3 years).

Also, general unsecured debts are usually discharged under Chapter 7 without you paying anything on them—except in the unusual situation that some of your assets are not exempt (protected) and are sold by the bankruptcy trustee to pay creditors. In a Chapter 13 case you may have to pay a portion of the general unsecured debts. That depends on your budget and how much other more important debts you have to pay ahead of them.

In general, if all you have are business and personal general unsecured debts, and they don’t total more than the maximum stated above, you probably need a Chapter 7 case. Chapter 13s are filed if your relatively high disposable income disqualifies you from Chapter 7, or you have other debts, like the tax and secured ones referred to above, that give you advantages under Chapter 13.

If have closed a business or are considering doing so, and you live in the Dallas-Fort Worth area, I can help you decide whether Chapter 7 or Chapter 13 is more appropriate for you. My name is Carrie Weir, and I’m a Texas bankruptcy attorney serving the Metroplex, especially the area around Rockwall, Heath, Greenville, Lavon, Wylie, Mesquite, and Rowlett. Please get in touch with me for a free and confidential consultation so that you can make informed choices about your debts and the rest of your financial life. Please call 972-772-3083 or use the contact form here. Thank you. I look forward to serving you.